28 Dec 2021

2021 in review pt 3 of 5: Derivatives on fire

2021 has taught us that crypto traders have a much heftier risk appetite than the average Joe - leading to massive volatility, long and short squeezes and plenty of market action.
The open interest in the bitcoin futures and perpetuals market peaked at $27.3 billion in the middle of April, and the market was much more leveraged towards further upside. We also saw high leverage in the futures market as bitcoin reached its $69,000 all-time high in November. The following charts illustrate 2021's wild tendencies in the futures market. 2022 prediction: Retail-traders haven’t learned anything from the liquidation cascades this year and will continue to go hard on leverage.
Funding rates settled after an overly exuberant Q1
Source: NYDIG
The perpetual swaps market ran wild throughout 2021, as the derivatives market fluctuated between fear and greed. Examining the funding rates is a very effective way to grasp the sentiment in the market. In Q1, we saw extreme greed and surging funding rates. Funding rates on Binance and Bybit periodically soared well above 0.1%, corresponding to an annualized interest rate of more than 100%. This summer, funding rates flipped negative, as sentiment went from greedy to fearful following the relentless Q2 sell-off. In the second half of the year, funding rates have been less extreme in both directions - suggesting that traders might have realized that taking the opposing side of the force that is the perp traders is an efficient way to gain yield in the crypto markets.2022 prediction: We will never see sustained positive funding rates like those we saw in Q1, 2021 again. 2021 lesson: Be careful when offshore exchange sentiment outpaces CME
Source: Skew
Activity in the futures market mirrors that of the perpetuals market. Futures basis premiums ran wild from February to April. The froth in the futures market could be even more evidently seen by comparing the soaring basis premiums on the offshore exchanges to those on CME – the futures exchange of the accredited, institutional investors. On April 14th, the 3-month futures traded at an annualized premium of 45% on the offshore exchanges, while CME saw a far more conservative premium of 12%. The basis premium since evaporated following the sell-off in April and May but again grew as market participants wanted to increase exposure into an exciting Q4. Just like with the funding rates, we saw far more suppressed basis premiums than in April, further backing our claim that specific traders gladly take the opposing trade to harness yield once markets brew with exuberance. 2022 prediction: We will never see sustained positive futures premiums like those we saw in Q1 2021 again. Nor will we see as immense of a gap between CME and the offshore market again as market efficiency improves.
The great rektoning
Source: Coinglass and Skew
We frequently talk about funding rates, futures basis and leverage, but few stats are better at highlighting the extreme risk appetite seen in the market this year than the liquidation volumes. We estimate that an astronomical $84.45bn worth of longs and $46.89bn worth of shorts have been liquidated in the BTC market alone this year. This is the price you pay for impatience and greed in the free markets. 2022 prediction: We will continue to see liquidation cascades as animal spirits continuously attracts hopeful traders to the casino that is 20-100x longs and shorts in bitcoin.
Binance the new top dog in the futures market
Source: Skew
Binance has been the largest bitcoin futures exchange by open interest 308 of the 360 days scoping this report. It started the year battling for the number one position against OKEx and CME, but as institutional interest dampened with the futures and perp markets running wild and Chinese regulatory pressure escalated, Binance manifested its position as top dog in the futures market. Bybit saw a brief stint as the largest exchange amid the craziest frenzy in April, whereas CME again had a period as the top market amid the launch of the futures-based ETFs. Lately, FTX has also seen impressive growth, showing signs of approaching Binance soon.  2022 prediction: Binance will maintain its position as the biggest bitcoin futures exchange by open interest but will face fierce competition from FTX. 2022 bonus prediction: The market will experience even more stringent regulation, making it challenging to maintain modus operandi as a free port for all who seek to trade with high leverage. Because of this, decentralized derivatives exchanges will attract more traders, despite the associated protocol risk.
Continuous high institutional demand for BTC and ETH exposure
Source: Skew
The open interest and trading volumes on CME’s bitcoin futures have ballooned this year. The activity on CME has particularly increased following the approval of several futures-based ETFs, with the open interest peaking at $5.5 billion by the end of October. Additionally, the ether futures on CME has seen stable and maintained growth in open interest since launch in February. These two charts suggest that there is a high demand from institutions to trade both bitcoin and ether, and we do not expect it to end anytime soon.  2022 prediction: CME’s importance in the price discovery of ether will grow.
Open interest booming in all corners of the market
Source: Coinalyze, Skew
While bitcoin’s open interest topped in April at $27.3 billion, the overall open interest in the crypto markets topped at $59.7 billion on November 8th. Throughout the year, we’ve seen interest into leveraged trades of altcoins explode, leading the bitcoin dominance to decline in tandem to the declining bitcoin dominance measured by market cap. 2022 prediction: The distribution of the open interest in the crypto futures market will continue to follow the market cap dominance closely. Relative differences between open interest share of an asset and its market dominance will create signal of oversaturated exposure in said asset.
Options see sustained traction in 2021
Source: Skew
The options market has seen sustained traction throughout 2021. Deribit has seen its market share growing continuously throughout the year, accounting for more than 90% of the OI in the options market. Up from 82% starting the year. Option flows have become an increasingly critical signal from the market, with indicators such as skew and IV contributing to assessing the state of the market. 2022 prediction: Deribit will experience increased competition from tradfi venues. This is part 3 out of 5 in our year in review article series. URL pt 1 URL pt 2 URL pt 4 URL pt 5
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